Foreign Exchange: Pound Bounces Back Against The US Dollar

The Pound rose against the US Dollar and the Euro yesterday, bouncing back from the previous day’s drop following the report that the UK economy had surprisingly contracted.

The rise of the Pound came after the minutes from the Bank of England’s last policy meeting showed that one more member, Martin Weale, joined Andrew Sentance in recommending an interest rate increase from the current 0.5%.

The governor Mervyn King said that consumer prices may breach the 5% barrier this year, but with the economy slumping back into a recession, the central bank faces a difficult balancing act in the months ahead.

On the foreign exchange markets, the Pound was up 0.5% against the US Dollar after the release of the minutes, rising to a high of 1.5899. It was also up yesterday against 14 out of the 16 most actively traded currencies.

The UK economy is hurtling towards a second recession and the Pound’s mini-rally yesterday will do little to cool concern over the threat of a stagflation or a downturn in growth. To that end, it may be prudent for sellers of Sterling to consider taking advantage of yesterday’s relief, or consider the benefits of a stop order to protect against a move lower.

A report this morning from Hometrack Ltd showed that UK house prices fell in January for the seventh month in a row. As Richard Donnell, director of research at Hometrack, commented “The supply of new homes coming to the market continues to fall” and added ” Concerns over the economic outlook and the biting reality of spending cuts are doing little to improve a fragile market defined by weak consumer sentiment and a lack of demad for housing.”

The average cost of a home in Britian fell 0.5% from December to £153,600, a seventh straight drop in prices. BoE policy maker Adam Posen has recently commented that he sees a downside risk to the UK property market going forward rather than appreciation.

EUR/USD

The Euro was close to a two-month high against the US Dollar yesterday, before a report in Germany that showed consumer prices rose at the fastest pace in two years, adding to recent reports that the economy is growing. The European Central Bank President Jean-Claude Trichet has reiterated that the Central Bank will do what is necessary to keep a lid on inflation and went out of his way to stress that the ECB’s credibility on price stability remains intact.

There are some factions of the German coalition government who believe that a restructuring is inevitable and want a quick solution to avoid a more damaging process later. Therefore, underlying tensions will remain a potentially negative factor for the Euro.

The focus yesterday fell on the FOMC interest rate announcement where the Fed left US interest rates unchanged at a record low.

The FOMC was slightly more optimistic in the tone and language used in the statement and the US Dollar rallied back towards $1.3650 last night.